V.S. Sirpurkar (Chairman) A.K. Tewary, Member (Revenue)

Mr.S.S.Khan For The Applicant :
Mr. G.C.Srivastava, Special Counsel, Mr. CH.Rajeswara Reddy, DCITIT, Hyderabad For The Department :

RULING

The Ruling of the Authority was Pronounced by

A.K Tewary J-The rulings were pronounced by a common order incx AAR Nos. 1045, 1060, 1078, 1087 & 1088 of 2011. Out of these, the applicant in AAR No.1060 and 1078 challenged the judgment in the Delhi High Court, by way of writ petition. The Hon’ble Delhi High Court set aside rulings in so far as it relates to the application nos. 1060 and 1078 and directed a rehearing of these applications.

2. The questions raised for the ruling for AAR 1060 are as under:-

(1) Whether, on the facts and circumstances of the case, the Settlement Amount payable by Satyam under the Stipulation to the Qualified Settlement Fund pursuant to the Judgment and Final approval of the US Court will be regarded as sum chargeable under the provisions of the Act in the hands of the QSF?

(2) For the purposes of deducting tax at source under Section 195 of the Act on the transfer of the Settlement Amount to the QSF, whether Satyam can take into account the chargeability of the Settlement Amount in the hands of the Authorized Claimants, as defined in paragraph 1(e) of the Stipulation?

(3) Whether on the facts and circumstances of the case, Section 195 of the Act will also apply to the QSF when it distributes the Settlement Amount to the Authorized Claimants pursuant to the judgment and final approval of the US Court?

(4) If the answer to Question No.1 or Question No.2 is in the affirmative and Satyam is required to deduct income tax under section 195 of the Act, at what rate shall income tax be deducted?

(5) If the answer to the Question No.3 is in the affirmative and QSF is required to deduct income-tax under section 195 of the Act, at what rate shall income tax be deducted?

3. The questions raised for the ruling for AAR 1078 are as under:-

(1) Whether, on the facts and circumstances of the case, any portion of the Settlement Fund payable by the PWC Entities under the Stipulation to the QSF pursuant to the Judgment and Final approval of the US Court will be regarded as sum chargeable under the provisions of the Act in the hands of the QSF?

(2) Whether, on the facts and circumstances of the case, for the purposes of deducting tax at source under section 195 of the Act on the transfer of the Settlement Fund Initial Escrow Account to the QSF, can the PWC entities take into account the chargeability of the Settlement Fund in the hands of the Authorized Claimants, as defined in paragraph 1(d) of the stipulation?

(3) Whether on the facts and circumstances of the case, section 195 of the Act will also apply to the QSF when it distributes the Settlement Fund to the Authorized claimants pursuant to the judgment and final approval of the US Court?

(4) If the answer to question No.1 or question No.2 is in the affirmative and income tax is required to be deducted from the Settlement Fund under section 195 of the Act, at what rate shall income tax be deducted?

(5) If the answer to question No.3 is in the affirmative and the QSF is required to deduct income tax under section 195 of the Act, at what rate shall income tax be deducted?

4. The rulings pronounced by this Authority in the order dated 27th August, 2012 were as under:

In AAR No.1060 of 2011, I rule that the settlement amount will be regarded as sum chargeable under the provisions of the Act as required under section 195 of the Act. On question No.2, I rule that the time to deduct the tax is when the amount is moved from the segregated account in India to the initial escrow account in the US. In view of the ruling on question No.2, no separate ruling on question No.3 is called for. On question No.4, I rule that the rate at which the tax is to be deducted is at 30%.

In AAR No.1078 of 2011, I rule on question No.1 that the amount payable to the Settlement Fund by A and B will be regarded as sum chargeable under the provisions of the Act in the hands of QSF. On question No.2, I rule that for the purpose of deduction under section 195, the entities A and B are not entitled to take into account the chargeability of the settlement fund in the hands of the authorized claimants. Question No.3 raised has to be raised before the tax authorities in US. Once the tax is deducted on the fund as a whole, in the present context, the obligation of QSF will come to an end. The other aspect is not for consideration now. On question No.4, I rule that the deduction of tax will be at the rate of 30%.

5. In the order dated 18th September, 2014, Hon’ble Delhi High Court observed as under:-

The primary question which was there before the Authority for Advance Rulings was whether the amount of the settlement funds which had been transferred from India to USA were chargeable to tax in India. In order to answer this question a primary issue that arose was whether the receipts in the hands of the beneficiaries were in the nature of capital receipts or revenue receipts. The Authority for Advance Rulings had proceeded on the basis that they were revenue receipts and it had so observed on the basis of an alleged submission to this effect made on behalf of the petitioner. That is not the correct position in as much as from the impugned Ruling itself it would be evident that the stand of the petitioner was that they were not revenue receipts but capital receipts not chargeable to tax. It was the further case of the petitioner that the settlement amounts would only go towards reducing the cost of acquisition of the American Depository Shares.

We are of the view that the Authority for Advance Rulings has rendered its ruling based upon the wrong premise that the petitioner had accepted the receipts to be in the nature of revenue receipts. Thus, the Ruling cannot stand. Consequently, we set aside the Ruling dated 27.08.2012 and remit the matter to the Authority for Advance Rulings to examine the position, first of all, in the light of whether the receipts were in the nature of capital receipts or revenue receipts and thereafter to determine as to whether those receipts were chargeable to income tax in India. The Authority for Advance Rulings has to examine this aspect in the context of Section195 of the Income-tax Act, 1961 and for that purpose it has to consider whether these receipts, if they are to be regarded as income, could be construed as income at the point of time at which the tax was to be deducted at source. These issues need to be examined by the Authority for Advance Rulings apart from the other issues that may arise including the question of any income having arisen in India, having been received in India or deemed to have accrued in India.

With these observations, the impugned advance Ruling dated 27.08.2012 is set aside and the matter is remitted to the Authority for Advance Rulings to consider the matter afresh in the light of our observations and with the hope and expectation that the Ruling would be given at an early date. The writ petitions are allowed to the aforesaid extent. No costs.

6. The facts in both applications are similar and arguments adduced by the applicants’ counsel are also same. Therefore, it will be sufficient to set out the facts in one case, i.e. Satyam Computer Services, and pronounce the rulings which will apply in the case of PWC also.

7. Satyam Computers Services Limited is an Indian company incorporated under the Indian Companies Act, 1956. Its shares were listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). In May 2001, it issued 14.5 lakhs American Depositors Shares (ADS) which were listed on the New York Stock Exchange (NYSE). In May, 2005 it issued another 130.41 lakhs ADS and listed on NYSE. On 7.1.2009 the then Chairman of Satyam filed a letter to the Board of Directors admitting that the company’s balance-sheet was inflated on account of false inflated receipts, incomes and profits over several years. As a result of public disclosure of this fraud the prices of Satyam ADS fell on NYSE from USD 9.35 on 7.1.2009 to USD 1.14 on 9.1.2009. Several US investors of Satyam filed suits against Satyam in various jurisdictions in United States claiming damages. All these suits were consolidated on 9.4.2009 by the United States judicial panel on multi district litigation into one proceeding in the United States Court for the Southern District of New York. On 12.5.2009 the United States Court appointed Lead Plaintiffs in the action and approved their selection of the applicant as the Lead Counsel. On 17.7.2009 a consolidated class action complaint was filed on behalf of the Lead Plaintiffs.

8. The claims in the Complaint were filed on behalf of a Class of investors comprising of (i) persons and entities who purchased or otherwise acquired Satyam ADSs traded on the NYSE, and (ii) persons and entities residing in the United States that purchased or otherwise acquired Satyam ordinary shares traded on the NSE or the BSE between 06.01.2004 and 06.01.2009.

9. Lead Plaintiffs submitted in the Complaint that, in ignorance of Satyam’s true financial condition and relying upon the integrity of the market place and Satyam’s financial statements , reports and filings with the SEC and NYSE, etc., containing false and misleading information, the Plaintiffs were defrauded in acquiring Satyam securities at artificially inflated prices. Upon public disclosure of true facts concealed from US authorities in the fillings made by Satyam before the SEC and NYSE, the market prices of these securities declined sharply. The Plaintiffs claimed that as a direct and proximate result of these wrongful acts and misconduct of Satyam and its statuary auditors Price Waterhouse, the Plaintiffs suffered damages for which Satyam and the other defendants were liable. On 16.02.2011 a Settlement Agreement was reached between Lead Plaintiffs and Satyam, whereby in lieu of Satyam paying USD 125 million the Lead Plaintiffs and the Class Members, agreed to release and waive their claims against Satyam subject to the judgment of the US court. The Settlement Agreement provided that the obligations incurred pursuant to it are in full and final disposition of the Complaint with respect to Satyam, subject to approval of US Court and final operation of its judgment.

10. The scheme of payment of the settlement amount as per settlement agreement was as under:-

a. Satyam will open a bank account in India, called Segregated Account, and deposit USD 125 million into it in Indian currency.

b. After preliminary approval of the Settlement Agreement from the United States Court is obtained, Satyam will, with the approval of the Reserve Bank of India (RBI), transfer the amount from Segregated Account to a bank account to be opened by Satyam in United States called “Initial Escrow Account”. The settlement amount in this account remained the property of Satyam and under the custody of the United States Court.

c. Upon final judgment and approval of the United States Court, the Settlement Amount will be transferred from the Initial Escrow Account to the Final Escrow Account, which is a Qualified Settlement Fund (QSF). Within the meaning of United States Treasury Regulations QSF is a fund, account or trust established pursuant to a United States Court order to resolve or satisfy contested or uncontested claims that have resulted from an event or a related series of events that has occurred and that has given rise to at least one claim asserting liability arising out of a tort, breach of contract, or violation of law. As per United States Tax Regulations, QSF is a separate United States person and a tax resident of a United States subject to entity level tax.

11. All funds held in the Initial Escrow Account or the Final Escrow Account, as the case may be, shall be deemed to be in the custody of the US court and shall remain subject to the jurisdiction of the US Court until such time as the funds shall be distributed pursuant to the Stipulation and/or Orders of the US Court, or returned to Satyam upon the termination of the Settlement Agreement pursuant to its terms.

Before proceeding ahead we may list the chronology of main events in the case of Satyam (AAR No.1060) as under:-

Applicant’s arguments

12. The applicants have submitted that the transfer of funds in the Segregated Account remains the property of Satyam and Section 195 of the Act relating to the deduction of tax at source was not attracted. As per paragraph 1(x) of the Settlement Agreement the settlement amount and earnings thereon in the Initial Escrow Account also remains property of Satyam and Section 195 was not attracted at this stage also. After transfer of amount to the Final Escrow Account the legal title over the settlement amount gets transferred to QSF. However, QSF is a passthrough entity and the settlement amount remains with QSF till a competent Court decides on the legal claims to such amount. The applicants have argued that such amount is a capital receipt in the hands of QSF and not its income and even though QSF is a separate taxable entity, settlement amount is not its income either in United States or in India. It has been further submitted that at the time when the Settlement Amount was transferred to the QSF, the identities of the eventual authorized claimants were not known and there was no payment or credit to the account of any person liable to be assessed to tax. The applicants have relied upon the judgment of Hon’ble Supreme Court in the case of GE India Technology Centre Private Limited vs. CIT 2010 327 ITR 456 (SC) and UCO Bank vs. Union of India 2014 369 ITR 335 (Delhi).

13. The applicants have mentioned that after the ruling dated 27th August, 2012 Satyam was directed by the Income Tax Department to deduct tax on the settlement amount but at that time the identities and shares of amount of eventual claimants were not known and in such a situation there would be no liability of TDS under Section 195 because the amount payable to the non-resident had not became due. The applicant has put its reliance on judgment in ACIT vs. Motors Co.(2001)249 ITR 141 (Karnataka).

14. The applicants have also pointed out that the TDS certificates, after deduction of tax by Satyam, has not been issued so far. The issue of TDS certificates to the person from whose income-tax is deducted within a specified timeframe under Rule 3I IT Rulings, 1962 is a statutory duty. The fact that the TDS certificates have not been issued by the Satyam so far confirms that machinery provisions of TDS have failed.

15. According to the applicants the Settlement Amount is capital receipt. Complaint filed by Lead Plaintiffs shows that the wrongs alleged in the complaint related to filing of false and fraudulent statements by Satyam as a result of which the Plaintiffs were defrauded into payment of inflated prices on purchase of Satyam securities. Therefore, they exercised their right to sue Satyam/PWC in US for damages under US Laws for injury caused to them in US. The applicants have argued that the settlement amount is a compensation received by Plaintiffs in lieu of their agreeing not to pursue the class action complaint and it is a capital receipt in the hands of both QSF and the authorized claimants. The applicants have further submitted that this amount is not for making good any lost income as the class action did not allege any loss of income due to normal price fluctuations in stock exchanges. On the question of distinction between capital and Revenue receipt, the applicants relied upon the judgment in Kettlewell Bullen and Co. Ltd. vs. CIT (1964) 53 ITR 261 SC and Bombay- Burmah Trading Corpn.Ltd. vs. CIT (1971) 81 ITR 777 (Bombay). The applicants further argue that the settlement amount results only in reduction of losses incurred by the various claimants and are only parcel recoupment of the fraudulently inflated prices paid by the Plaintiffs for acquiring Satyam securities.

16. According to the applicants the Settlement Amount neither arises nor accrues nor can be deemed to arise or accrue in India under section 5(2) of the IT Act and the right to receive the Settlement Amount accrues in favour of QSF only on the US Court passing the final judgment and, therefore, such right accrued in the US and not in India. They have further submitted that section 5(2) (b) becomes applicable only when income is ‘deemed to accrue or arise in India’ under Section 9(1)(i) of the Act, directly or indirectly-

• through or from any business connection in India, or
• through or from any property in India, or
• through or from any asset or source of income in India, or
• through the transfer of a capital asset situate in India.

According to the applicants the Settlement Amount does not fall in any of the above categories qua the QSF or the Authorized Claimants, is clearly not arising to them from any ‘business connection in India’ or from any ‘property’ in India and they have not transferred any ‘capital asset’ in India.

17. The applicants have further argued that a mere right to sue is not a capital asset from which capital gains can arise. A mere right to sue is neither an actionable gain nor ‘property of any kind’ and, therefore, is not a capital asset within the meaning of Section 2(14) of the Income-tax Act. Reliance has been placed on the judgment in Union of India vs. Raman Iron Foundry, AIR 1974 SC 1265. It has been further stated that a mere right to sue cannot be transferred and it has no cost of acquisition. 18. The applicants have further stated that the Settlement Amount cannot be taxed as ‘income from any other source’ as the Settlement Amount allowed the Plaintiffs to partially recoup their losses and the estimated recovery was USD 1.36 per ADS against issue prices of 9.71 USD per ADS in May 2001 and USD 21.50 per ADS in May 2005. Therefore, there was no income that could be taxed under the head ‘Other Sources’. The applicants have further mentioned that even if the Settlement Amount is held to be taxable in India as income from Other Sources, statutory deductions prescribed in Section 57 of the Act e.g. attorney fees, administrative costs etc. as provided in Paragraphs 1(dd), 17 to 24 and 26 of the Settlement have to be allowed. Therefore, attorney’s fees (up to 17%), litigation expenses (up to USD 12.5 million) and litigation fund (for pursuing cases against non-settling defendants) have to be deducted. Further, QSF and the Plaintiffs are both tax residents of US. If the Settlement Amount is held to be income from Other Sources then Article 23 of the India-US DTAC gets attracted under which any income of US residents from other sources can be taxed only in the US and not in India. Article 23 is reproduced below:

“Article 23 – Other income – 1. Subject to the provisions of Paragraph 2, items of income of a resident of a Contracting State, wherever arising, which are not expressly dealt with in the foregoing Articles of this Convention shall be taxable only in that Contracting State.”

According to applicants paragraph 3 of Article 23 of the DTAC is also not applicable to the Settlement Amount as it has already been shown that it does not accrue or arise in India. As regards the contention of the Revenue that the word “arising” occurring in Article 23(3) of the DTAC should be interpreted to include “deemed to arise” as provided in Section 9(1)(i) of the Indian Income-tax Act, the applicants are of the view that such contention is entirely misconceived and contrary to ordinary rules of interpretation of Treaties. It was also pointed out that under US Treasury Regulations QSF has no liability to pay tax on the Settlement Amount. Therefore, it will also not get any relief under Article 25 of Indo-US DTAC for the TDS deducted in India.

Revenue’s arguments

19. The Revenue has argued that the ruling given by the Authority on 27.8.2012 was accepted by Satyam and acted upon by the concerned parties. It was not a unilateral act of Satyam but other applicants have also agreed to the procedure of deducting and paying tax if the Authority so ruled. Satyam has already deducted the necessary tax and paid to the Government account in accordance with the terms of settlement. According to the Revenue questions 2, 3, 4 and 5 of the applicant relate to deduction of tax under section 195 by the payer and these questions have lost their relevance because the taxes have been deducted and paid by Satyam. Therefore, these questions are no longer open to adjudication. According to the Department of Revenue there is no provision in the Income-tax Act whereby the payer-deductor having not disputed the ruling and having acted upon it can still be entitled to receive back the amount so deducted and paid. The refund of taxes deducted at source can be given only to the payer, i.e. QSF. The Department has further mentioned that the only valid question for consideration by this Authority is question No.1 which is whether the amount paid by Satyam to the QSF can be regarded as sum chargeable to tax under the provisions of the Act in the hands of QSF.

20. As regards the issues raised by the applicant’s counsel, the Department has given a point wise reply, the gist of which is as under:-

a. The Department argues that the submission of the applicant that Section 195 is not applicable to settlement amount at any stage of proceedings is irrelevant in the facts and circumstances of the case as these exist at present.

b. According to the Department issue of certificate of TDS to the payee is a matter between the payer and the payee and the Revenue, under the law, has no role to play.

c. The Department has pointed out that the amount was paid by Satyam to QSF, which is a legal entity under the US Law and would also be an assessable entity under the Indian Law as an artificial jurisdictional person or as an association of persons deriving its existence from the laws of the United States and, therefore, it is incorrect to suggest that TDS machinery has failed in this case. In fact, the machinery has already worked. It is open to Satyam to issue certificate of tax deduction to the payees who are taxable entities in their own rights and also in their representative capacity representing a class of Members.

d. The Department has further submitted that Indian tax laws also stipulate the initiation of proceedings and making of assessments of persons in respect of income of other persons in respect of which they are assessable as Representative Assessees. The definition of “assessee” in section 2(7) includes representative assesses. The provisions contained in sub-clauses (i) and (iii) of Section 160(1) clearly provides for the circumstances under which an entity may be regarded as representative assessee and the entire procedure/machinery for levy and collection of taxes is applicable to such representative assesses by virtue of the provisions contained in section 161.

e. As regards the chargeability of the settlement amount in the hands of QSF in its own capacity, it has been submitted that QSF is admittedly a taxable entity.

f. According to the Department, the claim of the recipient, with regard to the settlement amount, is against the ‘lost income’. Satyam was in no way concerned with the loss of capital (Share or ADs in this case) of the claimants. The shares had already been sold by the investors on their own. The damages were determined / settled long after the sale of the asset (shares or ADs). Hence, the compensation payable by Satyam was in no way related to the loss of income generating asset (shares) but to the income which the investors would have earned from the asset (if the fraud had not taken place).

g. The Department has further submitted that contention of the applicants that the receipts are not for the lost income but are compensation for the inflated price they paid as the cost of acquisition on the basis of Annual Reports disseminate and published by Satyam is misconceived for the following reasons:

i. Share prices are not necessarily dependent on the financial results or the net worth of the company. Even after poor financial results, some statement of the company regarding an upcoming project or some policy announcement of the respective governments regarding incentives in future, merger or acquisitions or the overall market sentiments may still keep the prices high or vice versa.

ii. Compensation was not for the cost of acquisition, the compensation was worked out only for shares/ADs sold at a loss between 15.09.2008 and 06.04.09 or those not sold as on 06.04.2009. No compensation is agreed to be given to the shares/ADs sold prior to 14.09.2008 irrespective of their cost of acquisition.

iii. Compensation was determined with reference to the fall of prices at the point of sale. The amount of compensation represents the loss/lower realization at the point of sale of shares.

h. As regards capital gains, the Department submits that the income payable by Satyam may not be characterized as capital gains since it is paid as compensation for the loss of income to the payees arising as a result of fraud and manipulations of accounts done by Satyam. It is not paid in consideration for transfer of any capital asset (which by its very definition in section 2(14) would include property of any kind extending the scope to all rights and entitlements). Hence the income not being exempt in section 10 (Chapter III) and not falling under any other head would need to be characterized as “Other Income” chargeable to tax under section 56(1) of the Act.

i. Without prejudice and as an alternate submission, the Department has contended that if it is held that the receipts are capital in nature, the income would be characterized as capital gains and would be liable to tax by virtue of section 45 of the Act.

j. According to the Department the income accrued/arose in India. The judgment of the US Court was only one of the different options available to enforce the rights which existed in India, as the company was located in India and the fraud happened in India. The efficacy of the option and its final choice would not alter the place of accrual. The proximate cause of the compensation was the fraud and misrepresentation happening in India. The agreement between the parties on the amount of compensation was to compensate for the damage suffered as a direct consequence of fraud. In terms of section 9(1) (i) of the Act, any income arising directly or indirectly through or from an asset or source of income in India shall be deemed to arise in India. The word “through” has been clarified by the Finance Act of 2012 with retrospective effect from 01.04.1962 to mean “by means of”, “in consequence of” or “by reason of”. The Department has submitted that the source of income of the amount payable to QSF is in India and the primary source of income is the shares in Indian Company which has their situs in India. The ADs issued to the US Investors are nothing but derivatives, representing certain number of Shares in the Indian company. These cannot have their situs other than in India.

k. As regards Article 23 of DTAA it has been stated by the Department that the narrow view taken by the applicant that the income deemed to arise in India under section 9 is within the ambit of Article 23 is wholly erroneous. The word “arising” is not defined in the Income Tax Act as well. However, section 9 extends the scope of taxable income by deeming certain income which otherwise do not arise in India as arising in India. A legal fiction created under section 9 to enlarge the scope of accrual/arising of income cannot be nullified by putting a restricted meaning to the word “arising” used in the treaty. A deemed arising of income is nonetheless arising of income under the law, Article 23 of the DTAA does not make any difference between arising and deemed arising. The difference contained in the domestic law cannot be imported in the treaty nor can the DTAA be read with IT Act in hand.

l. As regards the account being Custodia Legis it was stated that amount to be transferred from the Initial Escrow Account was not on taxes, if any, payable in India as per the terms of the agreement. The amount needed the custody of the US Court, if at all to be so, would be only that part of the money which is available for distribution and not the amount of statutory taxes which were to be paid, if found payable by the Authority.

INFERENCES

21. We have summarized the contentions of both parties in earlier paragraphs. The following issues arise for our consideration:

i. Whether questions no. 2, 3, 4 and 5 are required to be adjudicated after the ruling dated 27.08.2012 was accepted by Satyam / PWC and accordingly tax was deducted by them from settlement amount kept in Initial Escrow Account in New York and paid to Government account?
ii. Whether settlement amount transferred to QSF is capital or revenue receipt?
iii. Whether settlement amount is against surrender of ‘right to sue’ as claimed by applicants or it represents loss of potential income without loss of capital asset as claimed by revenue?
iv. Whether settlement amount can be characterized as ‘capital gains’ or ‘income from other sources’?

At this juncture it would be appropriate to recapitulate the facts to see how the settlement agreement was arrived at. On 7.1.2009 Chairman of Satyam admitted that the balance sheet of Satyam was inflated on account of false, inflated receipts, incomes and profits over several years. Satyam also submitted statement before SEC that PWC audit reports and opinions in relation to Satyam’s financial statement from the quarter ended June 30, 2000 until quarter ended September 30, 2008 should no longer be relied upon. Such public disclosure caused price of Satyam ADS on NYSE fall drastically from US dollar 9.35 on 7.1.2009 to US dollar 1.14 on 9.1.2009. Several suits filed by US investors in different US Courts claiming damages were consolidated and subsequently four of the Plaintiffs were appointed Lead Plaintiffs by the US Court. On 17.7.2009 a consolidated class action complaint was filed on behalf of Lead Plaintiff in the US Court, alleging breach of several sections of US Securities Act, 1933 and US Securities Exchange Act, 1934. The Plaintiffs claimed that as a direct and proximate result of wrongful acts and misconduct of Satyam and its auditors, the plaintiffs suffered damages for which Satyam and other defendants were liable. On 16.2.2011 a settlement agreement was arrived at between Lead Plaintiffs and Satyam whereby in lieu of Satyam paying US dollar 125 million, the Lead Plaintiffs and the class members agreed to release and waive their claims against Satyam. Following the announcement of the Satyam settlement, PWC entities and Lead Plaintiffs commenced negotiations regarding claims against PWC entities. Subsequently the PWC entities also entered into the settlement agreement to eliminate the burden, expense, uncertainty and distraction of further litigation and agreed to pay US dollars 25.5 millions as a consideration for their release in terms of the stipulations. As per the scheme of payments when the amount was kept in segregated account in Indian currency in India, Satyam/PWC remained owner of such account. When the amount was transferred to Initial Escrow Account in US, the amount still remained the property of Satyam and it was only when the amount was transferred to Final Escrow Account, the amount did not remain the property of the Satyam. As per paragraph 14 of the Settlement agreement all funds in the Initial Escrow Account or Final Escrow Account shall be deemed to be in the custody of the US Court and shall remain subject to the jurisdiction of the US Court until these are disposed of under orders of the US Court. It is only upon transfer into the Final Escrow Account that the settlement funds became Qualified Settlement Fund (QSF). Under US Treasury Regulations, a QSF is a fund, account or trust established pursuant to US Court Order to resolve or satisfy contested or uncontested claims arising out of a tort, breach of contract, or violation of law, subject to continuing jurisdiction of US Court. QSF is a separate taxable entity under US Tax Law. However, the amount transferred to QSF to resolve or satisfy a disputed law is excluded from its gross income for US tax purposes.

22. In this case the rulings were pronounced on 27.8.2012 holding that the settlement amount will be regarded as sum chargeable to tax as required under section 195 of the Act and the deduction of the tax will be made by the payer when the amount is moved from the segregated account in India to the initial Escrow Account in the US. Satyam had already transferred USD 125 million from the segregated account in India to Initial Escrow Account in New York on 27.04.2011. After the ruling payer i.e. Satyam, deducted the tax @ 30% from amount lying in Initial Escrow Account and paid to the Government Account. The balance of the amount was transferred to the Final Escrow Account opened by Lead Counsel in USA and it became Qualified Settlement Fund (QFS).

23. The question Nos. 2, 3, 4 & 5 relate to deduction of tax at source on the transfer of the settlement amount to the QSF and on further distribution of this amount by QSF to the authorized claimants. In view of the fact that taxes have already been deducted at source in accordance with the rulings given, the Department of Revenue is correct in saying that the only question which survives is question No.1. The taxes have been deducted by the payers and refund, if any, can be paid to QFS only on filing of returns of income. The TDS certificates are issued by payer-deductor and the Revenue has no role in this. There is no provision in the Income-tax Act by which a payer can obtain refund. Therefore, all issues raised by the applicant now relating to wrong deduction of tax at source by payer and non-issue of TDS certificate are not relevant and has no bearing on the main issue, i.e. whether the settlement amount payable by Satyam to the QSF can be regarded as sum chargeable in the hands of QSF under the provisions of the Act. While setting aside the earlier ruling, the Hon’ble High Court has also asked this authority to examine the position, first of all, in the light of whether the receipts were in the nature of capital receipts or revenue receipts and thereafter to determine as to whether those receipts were chargeable to income-tax in India.

24. Section 195 puts responsibility on the payer making payment to a non-resident to deduct taxes on any interest or any other sum chargeable under the provisions of this Act. This means that the payer should deduct taxes at the time of its credit or payment to the non-resident only if the amount involved is chargeable to tax in India. The Hon’ble Supreme Court in GE India Technology Centre Private Limited vs. CIT 2010 327 ITR 456 has held that the law for deduction u/s 195 arises only when the sum paid is chargeable to tax in India but not otherwise. Even in light of this the only relevant question to be considered is whether the settlement amount can be treated as sum chargeable to tax because other events like deduction of tax at source and rate thereof have already taken place.

25. Coming back to the nature of settlement amount, we notice that the complaint filed by Lead Plaintiffs before the US Court was in respect of the fraud committed by Satyam by filing various false annual reports and quarterly reports before US authorities for 2004 and 2005 along with a certificate of verification by PWC to artificially inflate market price of its securities. This action caused injury to non-resident investors who paid high premium for ADS which were traded on NYSE and not in India. Thus, these torts were committed by Satyam and PWC in USA and for this reason SEC had the jurisdiction to levy penalty. The relief claimed by the plaintiffs under US Securities Act and US Exchange Act sought compensatory damages, compelling the defendants (Satyam and others) to disgorge illegally gained proceed and restitution of investor’s money defrauded by them. It is clear that the plaintiffs have exercised their right to sue Satyam/PWC in US for damages under US laws for injury caused to them in US. The settlement agreement clarifies that Satyam entered into the settlement without any admission of any wrong doings on its part and to enhance its credibility and business opportunities in the US. On the other hand, the plaintiffs entered into the settlement recognizing the inherent risks associated in prosecuting a complex action of this nature through trials and appeals etc. The final judgment of the US Court dated 13.09.2011 is a decree issued by the Court under US Federal Rules of Civil Procedure. The Court directed that lead plaintiffs and Members of class shall be deemed to have fully and finally released and discharged their claims under Satyam. It is clear that the settlement amount is a compensation received for not pursuing the class action complaint and liability of Satyam arose only after the decree of the US court.

26. Both the applicant and the Revenue have cited a number of cases on distinction between capital and revenue receipts. Some of the important cases cited by them are:-

(i) Kettlewell Bullen & Co. Ltd. V. CIT [1964] 53 ITR 261 (SC)
(ii) Karam Chand Thapar and Bros. Ltd. V. CIT [1971] 80 ITR 167 (SC)
(iii) CIT v. Prabhu Dayal [1971] 82 ITR 804 (SC)
(iv) CIT vs Barium Chemicals 1987 31 Taxman 471 AP

The issue relating to distinction between capital and revenue receipts has engaged the attention of courts in a large number of cases. However, in order to decide whether or not a payment is capital or revenue receipt, it is necessary to look into its true nature and substance. In the case of CIT vs Barium Chemicals a general principle was enunciated that if the payment is received in the ordinary course of the business for loss of stock in trade it is revenue receipt and if, on the other hand, the receipt is towards compensation for extinction or sterilization partly or fully of profit earning source (capital assets) such receipt not being in the ordinary course of the business, it must be construed as capital receipt. In the case of Kettlewell Bullen and Company , the Apex Court analyzed a large number of cases and concluded as under:-

“On analysis of these cases which fall on two sides of the dividing line, a satisfactory measure of consistency in principle is disclosed. Where on a consideration of the circumstances, payment is made to compensate a person for cancellation of a contract which does not affect the trading structure of his business, nor deprive him of what in substance is his source of income, termination of the contract being a normal incident of the business, and such cancellation leaves him free to carry on his trade (freed from contract terminated) the receipt is revenue : Where by the cancellation of an agency the trading structure of the assessee is impaired, or such cancellation results in loss of what may be regarded as the source of assessee’s income, the payment made to compensate for cancellation of the agency agreement is normally a capital receipt. .”

When this general principle to identify capital or revenue receipt is applied to the facts in this case, it is clear that the nature of settlement amount in the hands of QSF is capital only because this has been received not to compensate the loss suffered but in lieu of surrender of right to sue.

27. The Revenue has argued that the nature of income has to be examined from the perspective of payees of such income and according to them the claim of the recipient is against the ‘lost income’. It is not possible to accept the stand of revenue that the settlement amount is a claim against the ‘lost income’ on the ground that the compensation payable by Satyam was related to the income which the investors would have earned from the assets if the fraud had not taken place. It is also not possible to accept that the settlement amount represents higher realization value of shares and, therefore, would be revenue because the surrender of “right to sue” can never qualify as income. On the one hand the Revenue is saying that the compensation was worked out only for shares/ADS sold at a loss between 15.9.2008 and 16.4.2009 or those not sold as on 6.9.2009 and on the other hand it is arguing that this represents income which investors would have earned in future. This is contradictory. Moreover, the settlement amount was not worked out on the basis of loss suffered between 15.9.2008 & 16.4.2009 and on 6.9.2009 because such data was presented only to show that manipulation and fraud in accounts led to sharp fall in price of ADS. The data was presented to establish that fraud had taken place because of which investors had to purchase ADS / shares at artificially inflated price.

28. The term income has been defined in section 2(24) of the Act. The Privy Council in CIT vs Shaw Wallace & Co (ILR 59 Cal 1343) defined income as under:-

“Income, their Lordships think, in the Indian Income-tax Act, connotes a periodical monetary return ‘coming in’ with some sort of regularity, or expected regularity from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one whose object is the production of a definite return excluding anything in the nature of a mere windfall.”

The settlement amount received as per the Court Order is not a periodical monetary return. As it is against surrender of ‘right to sue’, it is not linked with income generating apparatus, i.e. shares of Satyam. It can also not be said that it relates to any sort of business activity carried on by the QSF. In the circumstances the settlement amount has to be characterized as capital receipt. Once the character of receipt is capital in nature, it goes outside the scope of income chargeable to tax unless it is specifically brought within the ambit of income by way of specific provisions of the Income-tax Act.

29. We also notice that the most important point here is that we have to consider the nature of receipt in the hands of QSF which is not doing any activity to earn such receipt which may qualify as income. QSF is not in the business of suing and seeking settlement amount. Surrender of ‘right to sue’ has also been made by investors and not by QSF. Under no circumstances the theory of loss of future income would apply to QSF as neither is it owner of ADS nor it is doing any business relating to ADS. We are required to give ruling whether settlement amount in the hands of QSF is chargeable to tax. We are not considering whether investors were doing any business of purchase and sell of shares. In any case the settlement award to investors also has been given only because they have agreed not to pursue the complaint. QSF is only custodian of this amount till it is finally disbursed.

30. Now we may also consider whether the settlement amount can be treated as capital gains in the hands of QSF. Section 2(24) of the Act specifically includes “(vi) any capital gains chargeable under section 45” within the ambit of income. Thus a capital receipts would be chargeable to tax only if it falls under section 45 of the Act (as capital gains) though capital receipt as such is not taxable. This principle was described by the Income Tax Appellate Tribunal (Mumbai) in Dhruv N. Shah v. Commissioner of Income Tax 88 ITD [2004] 118 as follows:

“Further, all receipts are not taxable under the Income Tax Act. Section 2(24) defines “income”. It is no doubt that this is an inclusive definition. However, a capital receipt is not income under section 2(24) unless it is chargeable to tax as capital gain under section 45. It is for that reason that under section 2(24) (vi), the Legislature has expressly stated, inter alia, that income shall include capital gain chargeable under section 45. Under section 2(24) (vi), the Legislature has not included all capital gains as income. It is only capital gain chargeable under section 45 which has been treated as income under section 2(24). Further under section 2(24)(vi), the Legislature has not stopped with the words “any capital gains”. On the contrary it is obviously stated that only capital gains which are taxable under section 45 could be treated as “income”. In other words, capital gains not chargeable to tax under section 45 fall outside the definition of “income” in section 2(24). Therefore, the words “chargeable under section 45” are very important. So, whenever an amount which is otherwise a capital receipt is to be charged under section 2(24), and when specifically so provides for not charging to capital gain for any reason under section 45, the same cannot be brought to tax as income by applying the general connotation under section 2(24)……”

31. In this case it is to be considered whether right to sue is property and a capital asset as defined u/s 2(14) of the Act and whether it is chargeable to tax. Section 2(14) defines Capital Asset to mean “property of any kind held by an assessee, whether or not connected with his business or profession”. Section 6 of the Transfer of Property Act states that “property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force.” Section 6 (e) notes that “a mere right to sue cannot be transferred”. Therefore, a ‘right to sue’ is property and thus Capital Asset as defined under section 2(14) of the Act but is not transferable. There cannot be any transfer of a right to sue under Indian law and any capital receipt arising from a right to sue cannot thus be considered capital gains under section 45. While examining the treatment of capital receipt from settlement and extinguishment of right to sue as Capital gains the Gujarat High Court in Baroda Cement and Chemicals v. CIT (158 ITR 636) held as under:

“The amendment of clause (e) of section 6 by the deletion of the italicized words has brought into sharp focus the distinction between property and a mere right to sue. Before the amendment, only the right to sue for damages arising out of a tortuous act fell within the ambit of the said clause. The right to sue arising ex-contractual, therefore, did not fall within the mischief of the clause even if it were a mere right to sue. After the amendment a mere right to sue, whether arising out of tortuous act or ex- contractual is not transferable.”

"Chagla C.J. had an occasion to consider this aspect of the law in Iron & Hardware Co. v. Shamlal & Bros., AIR 1954 Bom 423. The learned Chief justice observed as under (at p. 425):

“It is well settled that when there is a breach of contract, the only right that accrues to the person who complains of the breach is the right to file a suit for recovering damages. The breach of contract does not give rise to any debt and, therefore, it has been held that a right to recover damages is not assignable because it is not a chose-in-action. An actionable claim can be assigned but in order that there should be an actionable claim, there must be a debt in the sense of an existing obligation. But inasmuch as a breach of contract does not result in any existing obligation on the part of the person who commits the breach, the right to recover damages is not an actionable claim and cannot be assigned.

In my opinion, it would not be true to say that a person who commits a breach of the contract incurs any pecuniary liability, nor would it be true to say that the other party to the contract who complains of the breach has any amount due to him from the other party.

As already stated, the only right which he has is the right to go to court of law and recover damages. Now, damages are the compensation which a court of law gives to a party for the injury which he has sustained. But, and this is most important to note, he does not get damages or compensation by reason of any existing obligation on the part of the person who has committed the breach. He gets compensation as a result of the fiat of the court. Therefore, no pecuniary liability arises till the court has determined that the party complaining of the breach is entitled to damages. Therefore, when damages are assessed, it would not be true to say that what the court is doing is ascertaining a pecuniary liability which already existed. The court in the first place must decide that the defendant is liable and then it proceeds to assess what that liability is. But till that determination, there is no liability at all upon the defendant. "

Further, the Supreme Court in Union of India v. Raman Iron Foundry, AIR 1974 SC 265 held as under:

“When there is a breach of contract, the party who commits the breach does not eo instanti incur any pecuniary obligation, nor does the party complaining of the breach become entitled to a debt due from the other party. The only right which the party aggrieved by the breach of the contract has is the right to sue for damages. That is not an actionable claim and this position is made amply clear by the amendment in section 6(e) of the Transfer of Property Act, which provides that a mere right to sue for damages cannot be transferred. "

The Supreme Court endorsed the views of J. Chagla "This statement in our view represents the correct legal position and has our full concurrence.” If right to sue cannot be transferred and it has no cost of acquisition, the question of considering the same for the purpose of capital gains u/s 45 of the Act would not arise. Having said as above, it will have to be considered whether surrender of right to sue is covered under the provisions of section 2(47)(ii) i.e., the extinguishment of any rights therein and, if so, whether the extinguishment of rights is independent of transfer. This question had come up before the Apex Court in thecase of CIT vs Mrs Grace Collis and other 2001 248 ITR 323 wherein it was held as under:

We have given careful thought to the definition of transfer in Section 2(47) and to the decision of this court in Vanias case. In our view, the definition clearly contemplates the extinguishment of rights in a capital asset distinct and independent of such extinguishment consequent upon the transfer thereof. We do not approve, respectfully, of the limitation of the expression extinguishment of any rights therein to such extinguishment on account of transfers or to the view that the expression extinguishment of any rights therein cannot be extended to mean the extinguishment of rights independent of or otherwise than on account of transfer. To so read the expression is to render it ineffective and its use meaningless. As we read it, therefore, the expression does include the extinguishment of rights in a capital asset independent of and otherwise than on account of transfer.

In view of above, the right to sue can be considered for the purpose of capital gains. This has been further clarified by explanation 2 of Section 2(47) inserted by Financial Act, 2012 but effective from 1.4.1962. This explanation reads as under:-

“Explanation 2 – For the removal of doubts, it is hereby clarified that “transfer” includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of right has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India.”

So right to sue may be considered for the purpose of capital gains within the terms of section 45 of the IT Act which is a charging section. However, the charging section and the computation provisions under section 48 must go together. The Apex Court in the case of CIT vs BC Srinivasa Setty1981 128 ITR 294 had considered this issue and held that the “Charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section.” The Apex Court also held that “none of the provisions pertaining to the head ‘capital gains’ suggests that they include an asset in the acquisition of which no cost of acquisition can be conceived.” It is clear that even if right to sue is considered as capital asset covered under the definition of transfer within the meaning of section 2(47) of the IT Act, its cost of acquisition cannot be determined. In the absence of such cost of acquisition, the computation provisions failed and capital gains cannot be calculated. Therefore, right to sue cannot be subjected to income tax under the head ‘capital gains’.

The Revenue also agrees that settlement amount is not paid in consideration for any capital asset and cannot be characterized as capital gains. It is only as an alternative argument that they have brought the issue of capital gains.

32. According to Revenue the settlement amount is chargeable to tax as income from other sources under the provisions of section 56(1) of the Act. According to Revenue all kinds of income, which are not exempt and which are not chargeable under other heads (profit, salary, business and capital gains) would be taxable as other income and the amount paid by Satyam not being exempt in section 10 of the Act (Chapter III) and not falling under any other head would need to be categorized as other income chargeable to tax u/s 56(1) of the Act. There is no force in this argument. Section 56(1) primarily brings to charge income of every kind. Income is defined in section 2(14) of the Act and we have concluded, after elaborate discussions, that the settlement amount cannot be brought within the purview of income under the Income-tax Act. Further, section 56(1) contemplates only such source which does not specifically fall under any one of other four heads of income i.e. Salaries, Income from house property, profit or gains of business or profession, or capital gains. To come within the ambit of this section the following conditions have to be fulfilled:
a) There has to be an income (under section 2(24) read with section 4 and 5 of the Act).

b) That income should not be exempt under section 10 to 13A of the Act.

c) That income is neither salary income, nor income from house property, nor income from business/profession, nor capital gains. Though there are some exceptions to above which may be covered under section 56(2), yet such exceptions are specified in the Act. The income in the nature of settlement amount in lieu of surrender of ‘right to sue’ is not covered in this. Therefore, the question of treating the same as income from other sources would not arise at all.

33. The settlement amount takes the character of QSF only after it is transferred to Final Escrow Account. Before this and up to the stage of Initial Escrow Account the amount remains the property of Satyam. After it becomes QSF the amount remains under the jurisdiction of the US court and the amount is to be utilized only for the purpose of distribution to the authorized claimants. QSF has no ownership over the amount. In the circumstances the issue of QSF being a separate legal entity as per US law or being assessable as representative assessee in India becomes irrelevant. The QSF is merely acting as a custodian of the amount to be distributed to authorized claimants after the order of the US court is available. Such amount can be characterized Custodia Legis only and is not to be considered for tax purposes. It is for this reason that even under the US laws the amount transferred to a QSF to resolve or satisfy a disputed liability is excluded from its gross income for US tax purposes.

34. We are now in a position to answer the four issues identified by us for our consideration as mentioned earlier in paragraph 21. In view of the fact that tax on settlement amount has already been deducted, questions Nos. 2,3,4 & 5 are not relevant now. The settlement amount is capital in nature and has been approved by the US Court against surrender of ‘right to sue’. The settlement amount is not chargeable to tax either as capital gains or as income from other sources. We conclude that the settlement amount in the hands of the QSF is not chargeable to tax. Therefore, we do not think it is necessary to go into other issues like whether authorized claimants were not known to Satyam and therefore deduction of tax was not appropriate or whether such income accrues or arises in India or not or is deemed to accrue or arise in India or not. Once the answer to the question no.1 is in negative, such issues are not relevant and it is also not necessary to go into the issue of stages of transfer at which tax should have been deducted from the settlement amount. It is another matter that Satyam has deducted the tax and paid to the Government account after the earlier rulings were pronounced. The remedy for this is available in Income-tax Act for the payee to claim refund and for that appropriate action will have to be taken. We are also conscious of the fact that this Authority had taken a different view in the order dated 27/8/2012 that settlement amount was chargeable as required under section 195 of the Act. We have not agreed with this view for the reasons given in earlier paragraphs.

35. We, therefore, restrict ourselves to the ruling on question no.1 in both applications Nos. 1060 and 1078 as under:-

The settlement amount payable/paid by Satyam under the stipulation to the QSF pursuant to the judgment and final approval of the US Court cannot be regarded as sum chargeable under the provisions of the Act in the hands of QSF.

The Ruling is accordingly given and pronounced on this day of 12th January, 2015.